CFA level 3 study notebook1 2015 1

Reproduced and republished from 2015 Learning Outcome Statements, Level I, II, and III questions fromCFA® Program Materials, CFA Institute Standards of Professional Conduct, and CFA Inst

BOOK 1 - ETHICAL AND PROFESSIONAL

Readings and Learning Outcome Statements 10

StudySession 1 -Codeof Ethicsand StandardsofProfessional Conduct 16

StudySession 2 - EthicalandProfessionalStandardsin Practice 87

Self-Test-Ethical and Professional Standards 115

StudySession3-BehavioralFinance 138

StudySession4- PrivateWealth Management(1) 212

StudySession5- PrivateWealth Management(2) 299

Self-Test- PrivateWealth Management and BehavioralFinance 381

SCHWESERNOTES™ 2015CFALEVELIIIBOOK 1:ETHICALANDPROFESSIONAL STANDARDS, BEHAVIORALFINANCE,AND PRIVATEWEALTHMANAGEMENT

©2014 Kaplan,Inc.All rights reserved

Publishedin2014 by Kaplan,Inc

Printedinthe United StatesofAmerica

ISBN:978-1-4754-2783-7/1-4754-2783-2PPN:3200-5562

If this book does not have the hologram with the Kaplan Schweser logo on the back cover, it was

distributed without permission of Kaplan Schweser, a Division of Kaplan, Inc., and is in direct violation

of global copyright laws Your assistance in pursuing potential violators of this law is greatly appreciated.

Required CFA Institute disclaimer: “CFA Institute does not endorse, promote, or warrant the accuracy

or quality of the products or services offered by Kaplan Schweser.CFA®and Chartered Financial

Analyst® are trademarks owned by CFA Institute.”

Certain materials contained within this text are the copyrighted property of CFA Institute The following is the copyright disclosure for these materials: “Copyright, 2014, CFA Institute Reproduced and republished from 2015 Learning Outcome Statements, Level I, II, and III questions fromCFA®

Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute s Global Investment Performance Standards with permission from CFA Institute All Rights Reserved.”

These materials may not be copied without written permission from the author The unauthorized duplication of these notes is a violation of global copyright laws and the CFA Institute Code of Ethics.

Your assistance in pursuing potential violators of this law is greatly appreciated.

Disclaimer: The Schweser Notes should be used in conjunction with the original readings as set forth

by CFA Institute in their 2015 CFA Level III Study Guide The information contained in these Notes

covers topics contained in the readings referenced by CFA Institute and is believed to be accurate.

However, their accuracy cannot be guaranteed nor is any warranty conveyed as to your ultimate exam success The authors of the referenced readings have not endorsed or sponsored these Notes.

WELCOME TO THE 2015 LEVEL III

SCHWESERNOTES™

Thankyoufor trusting Kaplan Schwesertohelpyoureachyourgoals.Wecanhelpyou

preparefor the Level III CFA Exam and have donesoformanyofyourpredecessors

LevelIII iswell acceptedasbeing different from LevelsIandII.That difference leadsto

examfailurefor about half of candidates eachyear

Whenyouthink of how few candidates reach LevelIII,the failurerateisshocking,

untilyouacceptthat theexamisintendedtobe different Itishalf constructedresponse

questions Thepurposeof constructedresponse versus itemsetquestionsisto testhigher

level thinking, judgment, and the abilitytoorganizearesponse It differentiates how

well candidates know the material.Agood constructed response questionisonethata

highpercentageof candidates couldanswerif shownanswerchoicesa,b,andcbut they

areunabletoanswerthesamequestioninconstructedresponseform Theexamisalso

highlyintegratedacrosssubjects.Ifyoucheck the fine print from the CFAInstitute,it

will tellyouthat 85-90% of theexamcanbe portfoliomanagement.The other 10-15%

isethics andguesswhat thefocus of ethics will be? Portfoliomanagement.

Yourprevious study skillsareuseful but generally insufficient for LevelIII Letme stress

three related thingsyouwill needtodo.First,finish all the readings,classes,and basic

question practiceamonth before theexam.At Level I andII,mostofyougot most

of this done just before theexam Second,spend the last month focusedontaking,

reviewing, andretaking practiceexams Third,spendalotoftimewriting Buy three

newblueorblack ink ball pointpens Usethem only for writingout answers topractice

questions Wear themoutbefore theexam.We’llreturn tothese three requirementsin

our material,particularlyinthe classes

BasicPreparation

The SchweserNotes™arethe baseofourmaterial.Fivevolumescoverall18Study

SessionsandeveryLearning Outcome Statement(LOS).Thereareexamples, Key

Concepts, and Concept Checker questions foreveryreading.Atthe endof several of the

majortopicareas, weincludeaSelf-Test Self-Test questionsarecreatedtobe exam-like

inordertohelpyouevaluateyourprogress These SchweserNotes™provide the base for

yourpreparation and initial practice

Inadditiontobasic coverage of the material and practice questions thereare:

(1)Professor’sNoteswith tipstohelpyoulearnatopic,concept, orparticularly difficult

calculation;(2)Forthe Examnoteswith suggestionsonhowtostudy for theexam;

(3)Warm-Upsectionswithnecessarybackground materialnotdirectly foundinthe

LevelIIIcurriculum

Study Planning

To besuccessful, youneedastudy plan The simplest approachistodivide the material

soyouread and practice eachweek,finishing the material and allowingamonthforintense review.Our classesare agoodwaytoprovidestructure toyourplan.Agoodstudy plan includes the following

• Complete initial reading and question practice approximatelyamonth before the

exam.

Initial reading of SchweserNotes™ and/or CFA readings

Complete practice questionsin our SchweserNotes™,discussion questionsinour ClassNotes,and SchweserProTM QBank questions.Workquestionseveryweekortime cangetawayfromyou

Complete additional end-of-chapter questionsinthe CFA readingsastimeallows

Periodicallyreviewprevioussessions

• Useyour last month ofstudy forfinalprepandperformance

Complete andreviewall Schweserpractice exams

Dothesamewith the last threeyearsofCFAmorningexamsessionsand otherpracticeexamsfrom theCFA Institute

Reviewmaterial where needed andasindicatedbyperformanceonthe above

• Usethe last 7to 10daystoretakepractice examstosolidify skills (particularlyinconstructed response) and verify thatyou cansuccessfullyperform whatyouknow

Thoseofyouwhowant amoredetailed day-by-day study plancanusethe SchweserStudy Calendarto constructone

Wealso havearange of otherresourcesavailable.You canfindmoredetailsatSchweser

.com;just signinusing the individualusernameand passwordyoureceived whenyoupurchased the SchweserNotes™ I’ll highlightafew below:

Weekly ClassesLiveWeekly Classroom Programs Weoffer weekly classroomprogramsaround theworld Please check Schweser.comforlocations, dates,andavailability The classescansaveyou timeby directingyouwheretofocusineach reading and provide additionalquestionstowork during and after class

Both the live and online class candidatesreceiveaweekly class letter that highlightsimportantissues,specific studyhints,and possible pitfalls for that week’s material Itregularly addresses that keystumblingblock: the constructedresponsequestions

15-WeekOnline Classes Our15-weekonline classesareavailable live from 6:00to9:00 pmET(NewYorktime)or6:00to9:00 pmGMT(Londontime)beginninginJanuary.Theyareimmediately archived after each class andcanbe viewedasoftenas

desiredatany time.Thetentativescheduleis:

12) Risk Management and Derivatives;

SS14, 15

13) Derivatives; SSI 5

4) PM—Individuals and Institutional; SS5, 6

5) PM Institutional and Applied Economics;

SS6, 7

6) Applied Economics;SS7

7) Asset Allocation 1; SS8

14)Trading,Monitoring, andRebalancing;SS16

15) Evaluation, How to Study GIPS, and Exam Tips; SS17, 18

8) Asset Allocation 2;SS9

Classtimefocusesonkeyissues in each topicareaandapplied problem solvingof

questions.Candidates who wishformorebackground also haveourOn-Demand Video

Instructionthatprovidesmorebasic LOS-by-LOScoverage

Ask Your Instructor Inadditiontoyourclassroominstructor,Kurt Schuldes,CFA,

CAIA,andIcan answerquestions about the curriculuminrealtime.Emailresponse is

alsoavailable

LateSeasonPreparation

The material discussed above is intendedforbasic preparation and initial practice

The last monthshouldfocusonpracticeexamswithintense review,practice,and

performance

Multi-dayReviewWorkshops These pull together the material and focusonproblem

solving with additional questions.Ourmostcomplete late-seasonreviewcourses are

residence programs inWindsor,Ontario(WindsorWeek),Dallas/FortWorth,Texas

(DFWfive-day program), andthe New Yorkfive-dayprogram We also offer

three-day ExamWorkshopsin many cities (andonline)that combine curriculumreviewand

hands-on practice with hundreds of questions plus problem-solving techniques Please

checkSchweser.comfor locations,dates,and availability

Mock Examand Multimedia Tutorial The SchweserMockExamisoffered livein

manycitiesaroundtheworld andonlineaswell Theoptional Multimedia Tutorial

provides extended explanation andtopictutorialsto getyouexam-readyinareaswhere

you missed questionsonthe MockExam.Please check Schweser.comforlocations,

dates,andavailability

PracticeExams Wehavetwovolumes withthree,full six-hourexamsineach.In

additiontotheanswers, wediscusshow pointsareallocatedfor eachconstructed

response question

PastExamQuestions TheCFAoldexamquestions for the morningsessionof the

exam arereleased andarepartof your finalreview.Weprovidevideosfor each questionwithafullreview,solutionapproach, and pitfallstoavoid.But,becarefulto not over¬

relyontheoldquestions.Theyareonlyasampleof what can beasked.Theyare not

yourtest.Someareobsolete Staringatthemislike staringin your rearview mirroras you drive; youwillrunoff the road

Schweser’sSecretSauce® Onebrief volume highlights key material It willnotreplacethefullSchweserNotes™andclassesbutit isa great reviewtoolfor the last month

HowtoSucceedThereare noshortcuts Countonthe CFA Institutetothink oftestangles theyhave

notshown before.Beginyourstudy early and withaplan Read the SchweserNotesTM

Attendaliveoronline class each week and work practice questions Take quizzes oftenusingSchweserPro™Qbank.Atthe endofeach topicarea,taketheSelf-Testtocheckyour progress Reviewprevioustopicsperiodically.Use the CFAtexts tosupplementweakareasandforadditional end-of-chapterquestions Finish thisinitialstudyamonthbefore theexam soyouhave sufficienttimetotake,review,and retakePracticeExams

Iwould liketothank Kurt Schuldes,CFA, CAIA,and LevelIIIcontentspecialist;

BryanKnueppel, director of print production; andJaredHeintz,leadeditor;for theircontributionstothe2014LevelIIISchweserNotesTMfor the CFA Exam

Timetohit the books,DavidHetherington

DavidHetherington,CFA

VP and CFA Level III managerKaplan Schweser

Exam TopicWeights

1 Ethical and Professional Standards 10-15%

7 Portfolio Management and WealthPlanning

The CFAInstitutehas indicated that theseareguidelines only andnotspecific rules

theymustfollow.They have also indicated that all topicsexceptethicscanbe integrated

intoportfoliomanagementquestions

40-55%

Exam Format

The morning and afternoon of theexam usedifferentexamformats Eachisthree hours

long Both haveamaximumscoreof180pointsoutof the totalmaximumexam scoreof

360points

The morningexam isthree hoursof constructed response questions Usually there

are8to12questions with each question havingmultipleparts.Foreach question

part,youwill be directedtoansweroneither linedpaperorinatemplate Both the

paper andtemplatesareprovidedinthe question book Ifyoudonotanswerwhere

directed, youwillreceiveno scorefor that questionpart.The morningisusually

heavily devotedtoportfoliomanagementquestions Every question willstate aspecified

number ofminutes.Theminutes arethemaxscoreyou can receivefor that question

Mostquestions donothaveonespecific rightanswerbutarange ofacceptableversus

unacceptableanswers.Partial credit foran answer isnormal

Theafternoonisthe multiplechoice, itemsetstyle of question from LevelII.It’s three

hoursfor10six-question vignettes Tentimes six is60 individual questions and each has

a scoreof three points.Foreach question thereisone correctanswer: A,B, orC

READINGS AND

READINGSThefollowing materialisa reviewofthe Ethical andProfessionalStandards,Behavioral

Finance,andPrivateWealth Management principles designedtoaddress the learningoutcome statements setforthby CPAInstitute

STUDY SESSION 1

Reading AssignmentsCodeofEthics and StandardsofProfessionalConduct,CFA Program 2015Curriculum,Volume1,LevelIII

1 Codeof Ethics and Standards of Professional Conduct

2. Guidancefor StandardsI-VII

page 16page 16

STUDY SESSION 2

Reading AssignmentsEthical andProfessionalStandardsinPractice,CFA Program 2015Curriculum,Volume1,LevelIII

3 The Consultant

4 PearlInvestmentManagement(A), (B),and(C)

5 AssetManager Code of Professional Conduct

page 87page90page104

STUDY SESSION 3

Reading AssignmentsBehavioralFinance,CFA Program 2015Curriculum,Volume2,Level III

6 The BehavioralFinancePerspective

7 The BehavioralBiasesof Individuals

8 BehavioralFinanceandInvestment Processes

page138page167page 187

STUDY SESSION 4

Reading AssignmentsPrivateWealth Management(1),CFA Program 2015Curriculum,Volume2,LevelIII

9 Managing IndividualInvestorPortfolios

10.Taxes andPrivateWealth ManagementinaGlobalContext

page 212page251

STUDY SESSION 5

Reading Assignments

PrivateWealth Management(2), CFAProgram 2015Curriculum,Volume2,Level III

11.EstatePlanninginaGlobal Context

12.Concentrated Single AssetPositions

13 Lifetime Financial Advice:HumanCapital, AssetAllocation,and

Insurance

page 299page331

page364

LEARNING OUTCOME STATEMENTS (LOS)The CFAInstitutelearningoutcome statementsarelistedinthefollowing outline Theseare

repeatedineachtopicreview However,the order may have been changedinorderto geta

betterfitwith theflow ofthereview.

STUDY SESSION 1

The topical coverage corresponds with thefollowingCFA Instituteassigned reading:

1 Codeof Ethicsand StandardsofProfessional Conduct

The candidate should be ableto:

a. describe thestructureof the CFAInstituteProfessional Conduct Program and

the disciplinaryreview processfor the enforcement of the Code of Ethics and

Standardsof ProfessionalConduct,(page16)

b explain the ethical responsibilities required by the Code of Ethics and the

Standardsof ProfessionalConduct,including the multiple sub-sections of each

standard,(page17)

The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

2 Guidancefor StandardsI-VII

The candidate should be ableto:

a. demonstrateathorough knowledge of the Code of Ethics and Standards of

Professional Conduct by interpreting the Code and Standardsin various

situationsinvolvingissuesof professional integrity, (page21)

b recommendpractices andprocedures designedto preventviolationsof the Code

of Ethics and Standards of ProfessionalConduct, (page21)

STUDY SESSION 2

The topicalcoveragecorresponds with thefollowingCFAInstituteassigned reading:

3 The Consultant

The candidate should be ableto:

a. evaluate professional conduct and formulateanappropriateresponsetoactions

that violate the Code of Ethics and Standards of ProfessionalConduct,(page87)

iropriate policy andprocedural changes neededtoassurecompliance with the Code of Ethics and Standards of Professional Conduct

(page87)

b

The topical coverage corresponds with thefollowingCFA Instituteassigned reading:

4 PearlInvestmentManagement(A), (B),and(C)The candidate should be ableto:

a. evaluate professional conduct and formulateanappropriateresponseto

actionsthat violate the Code of Ethics and Standards of Professional Conduct

(pages91, 95, 100)

b formulate appropriate policy and procedural changes neededtoassurecompliance with the Code of Ethics and Standards of Professional Conduct

(pages91, 95,100)The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

5 Asset Manager Code of Professional ConductThe candidate should be ableto:

a. explain the ethical and professional responsibilities required by thesixcomponentsof the AssetManagerCode,(page104)

b determine whetheranassetmanager’spractices andproceduresare consistentwith theAssetManagerCode,(page111)

c. recommend practices and procedures designedto preventviolationsof theAssetManagerCode,(page104)

STUDY SESSION 3

The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

6 The BehavioralFinancePerspectiveThe candidate should be ableto:

a contrasttraditional and behavioral finance perspectiveson investordecisionmaking, (page138)

b contrastexpected utility andprospecttheoriesofinvestmentdecision making

The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

7 The BehavioralBiasesof IndividualsThe candidate should be ableto:

a. distinguish between cognitiveerrorsand emotionalbiases,(page167)

b discusscommonly recognized behavioral biases and their implications forfinancial decision making, (page168)

c identifyand evaluateanindividual’s behavioralbiases,(page168)

decisions and recommend approachestomitigate theireffects,(page168)The topicalcoveragecorresponds with thefollowingCFAInstituteassigned reading:

8 BehavioralFinanceandInvestment ProcessesThe candidate should be ableto:

a. explain theusesand limitationsofclassifyinginvestors intopersonalitytypes.

(page187)

c. discuss how behavioral factors influence portfolioconstruction, (page193)

d explain how behavioral financecanbe appliedtotheprocessof portfolio

construction,(page194)

e. discuss how behavioralfactors affect analyst forecasts and recommend remedial

actionsfor analystbiases,(page195)

f discusshowbehavioralfactors affectinvestment committeedecision making and

recommend techniques for mitigating theireffects,(page198)

describe how behavioral biasesofinvestorscanleadtomarket characteristics

thatmaynotbe explained by traditionalfinance, (page199)

g-STUDY SESSION 4

The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

9 Managing IndividualInvestor Portfolios

Thecandidate should be ableto:

a. discusshowsourceofwealth, measureofwealth,andstageof life affectan

individualinvestorsrisktolerance,(page213)

b explain the role of situational and psychological profilinginunderstandingan

individualinvestorsattitude towardrisk,(page213)

c. explain the influence ofinvestorpsychologyonrisk tolerance andinvestment

choices,(page216)

d explain potentialbenefits,for both clients andinvestment advisers,of havinga

formalinvestmentpolicystatement,(page217)

e. explain the process involvedincreatingan investmentpolicystatement.

(page218)

f :enrequiredreturnand desiredreturnand explain how these

affect the individual investor’sinvestmentpolicy

g explain howto setrisk andreturnobjectives for individualinvestorportfolios

anddiscussthe impact that ability and willingnesstotake risk haveonrisk

tolerance,(page219)

h discuss the majorconstraintcategories includedin anindividual investor’s

investmentpolicystatement,(page225)

i prepareand justify an investment policystatementforanindividualinvestor

(page230)

j determinethe strategicassetallocation thatismostappropriate foranindividual

investor’s specificinvestmentobjectives andconstraints, (page237)

k compareMonteCarlo and traditional deterministic approachestoretirement

planning andexplain the advantages ofaMonteCarlo approach, (page240)

The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

10.Taxes andPrivateWealth ManagementinaGlobalContext

The candidate should be ableto:

a. comparebasic globaltaxationregimesasthey relatetothetaxationof dividend

income,interestincome,realized capital gains, and unrealized capital gains

d explain howinvestmentreturnandinvestmenthorizonaffect thetaximpactassociatedwithan investment,(pages257, 258, 263)

e. discuss thetaxprofilesofdifferenttypesofinvestment accountsand explaintheir impactonafter-taxreturnsandfutureaccumulations,(page272)

f explain howtaxesaffectinvestmentrisk,(page277)

g discusstherelation betweenafter-taxreturnsand differenttypesofinvestor

tradingbehavior,(page278)

h explainthebenefitsoftaxloss harvesting and highest-in/first-out(HIFO)taxlotaccounting,(page280)

i demonstrate howtaxesandassetlocation relatetomean-varianceoptimization

(page285)

STUDY SESSION 5

The topical coverage corresponds with thefollowingCFA Instituteassigned reading:

11 EstatePlanninginaGlobalContextThecandidateshould be ableto:

a. discuss the purpose ofestateplanning and explain the basicconceptsofdomestic

estateplanning, includingestates,wills,and probate, (page299)

b explainthetwoprincipal forms ofwealthtransfer taxesanddiscusseffects ofimportantnon-tax issues,suchaslegalsystem,forced heirship,andmarital

propertyregime,(page300)

c. determineafamily’scorecapital andexcesscapital, basedonmortalityprobabilities andMonteCarlo analysis, (page303)

d evaluate the relativeafter-taxvalueof lifetimegiftsandtestamentarybequests

(page308)

e. explain theestateplanning benefit of making lifetime gifts when gifttaxes are

paid by thedonor,rather than the recipient, (page308)

f evaluatetheafter-tax benefitsof basicestateplanning strategies, includinggenerationskipping, spousalexemptions,valuationdiscounts,andcharitablegifts, (page311)

g explain the basicstructureofa trustand discuss the differences betweenrevocable andirrevocabletrusts,(page313)

h explainhow life insurancecanbeatax-efficientmeansof wealth transfer

12. Concentrated Single-AssetPositions

The candidate should be ableto:

a. explaininvestmentrisks associatedwithaconcentrated positioninasingleasset

and discussthe appropriateness ofreducing suchrisks,(page331)

b describe typical objectivesinmanaging concentrated positions, (page333)

c. discusstaxconsequencesand illiquidityasconsiderations affecting theman¬

agementof concentrated positionsinpublicly tradedcommon shares,privately

heldbusinesses,and realestate,(page333)

d discuss capital market and institutionalconstraintsonan investorsabilityto

reduceaconcentrated position, (page334)

e. discusspsychologicalconsiderations thatmaymakean investorreluctantto

reduce hisorher exposureto aconcentrated position, (page335)

f describe advisers’useof goal-based planninginmanaging concentrated

positions, (page335)

g explainusesofassetlocation and wealthtransfersinmanaging concentrated

positions, (page337)

h describe strategies for managing concentrated positionsinpublicly tradedcom¬

mon shares,(page340)

i discusstaxconsiderationsinthechoiceofhedgingstrategy,(page343)

j describestrategies for managing concentratedpositionsinprivately held

businesses,(page344)

k describe strategies for managing concentrated positionsinrealestate,(page348)

1 evaluate and recommend techniques fortaxefficiently managing the risks of

concentrated positionsinpublicly tradedcommon stock,privately held busi¬

nesses,and realestate,(page349)

Thetopicalcoveragecorrespondswith thefollowingCFAInstituteassigned reading:

13 Lifetime Financial Advice:HumanCapital, AssetAllocation,andInsurance

The candidate should be ableto:

a. explain theconceptand discuss the characteristics of “human capital”as a

componentofan investorstotalwealth,(pagea364,365)

b discussthe earningsrisk,mortalityrisk,and longevity risk associated with

human capital and explain how these riskscanbe reducedby appropriate

portfoliodiversification,lifeinsurance,and annuity products, (page364)

c. explain howassetallocation policyisinfluenced by the risk characteristics of

human capital and the relative relationships of human capital, financial capital,

and totalwealth,(page367)

d discuss howassetallocation and the appropriate level of lifeinsuranceare

influencedby the joint consideration of human capital, financial capital, bequest

preferences, risktolerance,and financialwealth, (page368)

e. discuss the financial marketrisk,longevityrisk,and savings risk faced

byinvestors in retirementand explain how these riskscanbe reduced by

appropriateportfoliodiversification, insuranceproducts, and savings discipline

(pages368,371)

f Discussthe relative advantages of fixed and variableannuitiesashedges against

longevityrisk,(page371)

recommend basic strategies forassetallocation and risk reduction when givenan

investorprofile of key inputs, including human capital, financial capital,stageof

life cycle, bequest preferences, risktolerance,and financialwealth,(pages367,

370, 371)

g-outcome statements set forth by CFA Institute This topic is also covered in:

Study Session 1

EXAM FOCUSEthics will be10to15% of theexamwithtwo orthreeitemsetquestions Constructedresponsequestionsarealso possible thisyear.Youcan expectquestions that couldhave beenonthe Level IIexam,but the Level III questions tendtofocusmoreoncompliance, portfoliomanagement issues,andquestions onthe Asset Manager Code

Prepare properly and ethicscanbean easier sectionof theexam.Thatisabig advantagewhenyoumove tothe questionsinother topicareas.

Justlike Level I and LevelII,ethics requires thatyouknow the principles and be abletoapply themtospecificsituationstomake the expected decision Some ethics questions

canbevaguewith unclear factssobe preparedtomakea“bestguess”on afew of thequestions Asyouread thematerial, payparticularattentiontothenumerousexamples(theapplication) Assoonasyou read,work the Schweser and CFA endof chapterquestions Readingprinciples without practice questions for applicationor vice versawillnotbe sufficient.Youneed both

Thereisapopular myth that downloading the StandardsofPracticeHandbook11thEdition(2014) isasubstitutefor the assigned materialorwill giveanadvantage Itlargely duplicates whatyouhave received directly from the CFAInstitutebut withimportantomissions.Mostimportantly,itdoesnothave all of the assigned questions

Theassignedmaterialis morepertinent and will betterprepare you

Beprepared and make thisan easierpartof theexam.

LOSl.a:Describe thestructureof the CFAInstituteProfessional ConductProgram and the disciplinaryreviewprocess for the enforcement of the Code

of Ethics and Standards of Professional Conduct

CFA®ProgramCurriculum,Volume1,page 9The CFAInstituteProfessional Conduct Programiscovered by the CFAInstituteBylaws and the Rules of Procedure for Proceedings RelatedtoProfessional Conduct TheProgramisbasedonthe principles of fairness of theprocesstomembers and candidatesand maintaining the confidentiality of theproceedings.The DisciplinaryReviewCommitteeof the CFAInstituteBoardof Governors has overall responsibility for theProfessional Conduct Program and enforcement of the Code and Standards

The CFAInstituteProfessional Conductstaff conducts inquiries relatedtoprofessional

conduct Severalcircumstancescan promptsuchaninquiry:

1. Self-disclosure by membersorcandidatesontheir annual Professional Conduct

Statementsof involvementincivil litigationoracriminal investigation,orthat the

memberorcandidateisthe subject ofawrittencomplaint

2 Writtencomplaints aboutamemberorcandidate’s professional conduct thatare

received by the Professional Conduct staff

3 Evidenceof misconduct byamemberorcandidate that the Professional Conduct

staff received through publicsources,suchas amedia articleorbroadcast

4 AreportbyaCFAexam proctorofapossible violationduringtheexamination

5 Analysis ofexammaterials and monitoring of social media by CFAInstitute

Onceaninquiry hasbegun, the Professional Conduct staffmayrequest(inwriting)an

explanation from the subject memberorcandidate andmay: (1) interviewthe subject

memberorcandidate, (2) interviewthe complainantorother third parties, and/or

(3)collect documents and records relevanttothe investigation

The Professional Conduct staffmaydecide:(1)thatnodisciplinarysanctionsare

appropriate,(2) toissueacautionaryletter, or (3)todiscipline the memberor

candidate.Ina casewhere the Professional Conductstaff findsaviolation has occurred

and proposesadisciplinarysanction,the memberorcandidatemayacceptorreject the

sanction.If the memberorcandidate choosestorejectthesanction,thematterwill be

referredto adisciplinaryreviewpanel of CFAInstitutemembersforahearing.Sanctions

imposedmayinclude condemnation by the member’s peersorsuspension of candidate’s

continued participationinthe CFA Program

LOSl.b:Explainthe ethicalresponsibilities requiredby the Code of Ethics

and the Standardsof ProfessionalConduct,includingthemultiplesub-sections

of each standard

CFA®Program Curriculum,Volume1,page 15

CODEOFETHICS

Membersof CFAInstitute[including Chartered FinancialAnalyst® (CFA®)

charterholders]and candidates for the CFA designation(“MembersandCandidates”)

must:

• Actwith integrity,competence,diligence,respect,andinanethicalmannerwith

the public,clients,prospectiveclients,employers, employees,colleaguesinthe

investmentprofession, and other participantsinthe global capital markets

l

1. Copyright2014, CFA Institute.Reproducedandrepublishedfrom “The Code of Ethics,”

fromStandardsofPractice Handbook,11thEd., 2014,withpermission from CFA Institute.

All rights reserved

• Place the integrity of theinvestmentprofession and theinterestsof clients abovetheirownpersonalinterests.

• Usereasonablecareandexerciseindependent professional judgment whenconductinginvestmentanalysis, makinginvestment recommendations,takinginvestmentactions,and engaginginother professionalactivities

• Practiceandencourageotherstopracticeinaprofessional and ethicalmannerthatwill reflect creditonthemselves and the profession

• Promotethe integrity and viability of the global capital markets for the ultimatebenefitofsociety

• Maintainand improve their professionalcompetenceandstrivetomaintainandimprove thecompetenceof otherinvestmentprofessionals

THE STANDARDSOFPROFESSIONAL CONDUCT

ProfessionalismIntegrity ofCapital MarketsDutiestoClients

DutiestoEmployersInvestmentAnalysis,Recommendations,andActionsConflictsofInterest

Responsibilitiesas aCFAInstituteMemberorCFACandidate

IIIIIIIVVVIVII

STANDARDSOFPROFESSIONAL CONDUCT2

I PROFESSIONALISM

A Knowledge of theLaw.Members and Candidatesmustunderstand andcomply with all applicablelaws, rules,andregulations (includingthe CFAInstituteCodeofEthics and StandardsofProfessionalConduct)ofanygovernment,regulatory organization, licensing agency,orprofessionalassociationgoverning theirprofessionalactivities.In theeventofconflict,Members and Candidatesmustcomply with themorestrict law, rule,or

regulation Members and Candidatesmust notknowingly participateorassist

inanyviolationoflaws, rules, orregulations andmustdisassociate themselvesfromanysuch violation

B Independence and Objectivity Members and Candidatesmust usereasonablecareand judgmenttoachieve andmaintainindependence and objectivityintheir professionalactivities.Members and Candidatesmust notoffer, solicit,or acceptanygift,benefit,compensation,orconsideration that reasonably could

be expectedtocompromise theirown oranother’s independence andobjectivity

C Misrepresentation Members and Candidatesmust notknowingly makeanymisrepresentationsrelatingtoinvestmentanalysis,recommendations,actions,

orother professionalactivities

D Misconduct Members andCandidatesmust notengage inanyprofessionalconduct involving dishonesty,fraud, ordeceitor commitanyactthat reflectsadverselyontheir professional reputation, integrity,orcompetence.

2 Ibid

II INTEGRITYOFCAPITAL MARKETS

A MaterialNonpublicInformation Membersand Candidateswho possess

material nonpublic information that could affect the value ofaninvestment

must not act or causeothersto act onthe information

B MarketManipulation.Membersand Candidatesmust notengage in practices

that distortpricesorartificially inflate trading volume with theintentto

mislead market participants

III DUTIES TOCLIENTS

A Loyalty,Prudence,andCare.Members and Candidates haveaduty of loyalty

totheir clientsandmust actwith reasonablecareand exerciseprudent

judgment.Membersand Candidatesmust actfor the benefit oftheir clients

and place their clients’interestsbefore theiremployer’sortheirowninterests

B FairDealing MembersandCandidatesmustdeal fairlyandobjectivelywith

all clientswhenprovidinginvestmentanalysis, makinginvestment

recommendations,takinginvestmentaction, orengaginginother professional

activities

C Suitability

1 When Members and Candidatesareinanadvisory relationship witha

client,theymust:

a. Makeareasonableinquiry intoaclient’sorprospective clients’

investmentexperience,risk andreturnobjectives, and financial

constraintspriortomakinganyinvestmentrecommendationortakinginvestmentactionandmust reassessand updatethis informationregularly

b Determinethataninvestmentissuitabletothe client’s financialsituationandconsistentwiththeclient’swrittenobjectives,mandates,andconstraintsbefore makinganinvestmentrecommendationor

takinginvestment action

c. Judgethesuitabilityof investments in thecontextof the client’s totalportfolio

2 When Membersand Candidatesareresponsiblefor managingaportfolioto

aspecificmandate,strategy,orstyle, theymustmakeonlyinvestmentrecommendationsortakeinvestment actionsthatareconsistentwith thestated objectives andconstraintsof the portfolio

D Performance Presentation.When communicatinginvestmentperformance

information,MembersorCandidatesmustmake reasonableeffortsto ensure

thatit is fair,accurate,andcomplete

E PreservationofConfidentiality.Membersand Candidatesmustkeep

information aboutcurrent,former,and prospective clients confidential unless:

1 The informationconcernsillegalactivitiesonthepartof the clientor

prospectiveclient,

2 Disclosureisrequired bylaw, or

3 The clientorprospective client permits disclosure of the information

IV DUTIESTOEMPLOYERS

A Loyalty Inmattersrelatedtotheir employment, Members and Candidates

must actfor the benefit of their employer andnotdeprive their employer of theadvantage of their skills andabilities,divulge confidentialinformation, orotherwisecauseharmtotheir employer

B Additional Compensation Arrangements Members and Candidatesmust not

acceptgifts,benefits,compensation,orconsideration thatcompeteswith,or

might reasonably be expectedto create aconflictofinterest with,theiremployer’sinterestunless they obtainwrittenconsentfrom all parties involved

C Responsibilities of Supervisors Members and Candidatesmustmakereasonableeffortstoensurethatanyonesubjecttotheir supervisionor

authority complies with applicablelaws, rules,regulations, and the Code andStandards

V INVESTMENTANALYSIS,RECOMMENDATIONS, ANDACTIONS

A Diligence andReasonableBasis.Members and Candidatesmust:

1 Exercisediligence, independence, and thoroughnessinanalyzing

investments,makinginvestment recommendations,andtakinginvestmentactions

2 Haveareasonable and adequatebasis,supported by appropriate researchand investigation, forany investmentanalysis,recommendation, or action

B Communicationwith Clients and Prospective Clients Members andCandidatesmust:

1. Disclosetoclients and prospective clients the basic format and generalprinciples of theinvestment processesusedtoanalyzeinvestments,select

securities,andconstructportfolios andmustpromptly discloseanychangesthatmightmaterially affect thoseprocesses

2 Disclosetoclients and prospective clients significant limitations and risksassociated with theinvestment process

3 Usereasonable judgmentinidentifying which factorsareimportanttotheirinvestmentanalyses,recommendations,oractionsand include thosefactors

in communicationswith clients and prospective clients

4 Distinguish between fact and opinioninthe presentation ofinvestmentanalysis and recommendations

C RecordRetention.Members and Candidatesmustdevelop andmaintain

appropriate recordsto supporttheirinvestmentanalysis,recommendations,

actions,andotherinvestment-relatedcommunications with clientsand

prospective clients

VI CONFLICTS OFINTEREST

A DisclosureofConflicts.Membersand Candidatesmustmake full and fair

disclosureof allmattersthat couldreasonably be expectedtoimpair their

independenceandobjectivityorinterfere with respective dutiestotheirclients,

prospective clients,and employer.Membersand Candidatesmustensure that

such disclosuresareprominent,aredeliveredinplain language, and

communicatethe relevant information effectively

B Priority of Transactions Investment transactions forclients and employers

musthavepriorityoverinvestment transactions inwhichaMember or

Candidateisthe beneficialowner.

C Referral Fees Membersand Candidatesmustdisclosetotheiremployer,

clients,andprospective clients,asappropriate, any compensation,

consideration,orbenefit receivedfrom,orpaidto,othersfor the

recommendationofproductsorservices

VII RESPONSIBILITIESAS A CFAINSTITUTEMEMBER OR CFA

CANDIDATE

A ConductasParticipants in CFA InstitutePrograms.Membersand Candidates

must notengage in anyconduct thatcompromisesthe reputationorintegrity

ofCFA InstituteortheCFAdesignationorthe integrity, validity,orsecurityof

CFA Institute programs

B ReferencetoCFAInstitute,theCFADesignation, andthe CFAProgram

When referringtoCFAInstitute,CFA Institutemembership, theCFA

designation,orcandidacyin the CFAProgram,MembersandCandidatesmust

notmisrepresentor exaggeratethemeaningorimplicationsofmembershipin

CFAInstitute,holding theCFAdesignation,orcandidacyintheCFA

Program

LOS 2.a:Demonstrateathorough knowledgeof the Code of Ethics and

Standardsof Professional Conduct by interpreting the Code and Standardsin

various situationsinvolvingissuesofprofessionalintegrity

LOS2.b: Recommend practices and procedures designedtopreventviolations

of the Code of Ethics and Standards of Professional Conduct

CFA®ProgramCurriculum, Volume1,page21

Professionalism1(A) Knowledge of theLaw.Members and Candidatesmustunderstand andcomply with allapplicablelaws, rules,and regulations (including theCFA InstituteCodeof Ethics and Standards of ProfessionalConduct)of anygovernment,regulatoryorganization,licensingagency,orprofessionalassociationgoverning theirprofessionalactivities Intheeventofconflict,Members and Candidatesmustcomply with the

morestrictlaw,rule,orregulation.Membersand Candidatesmust notknowinglyparticipateor assist in andmustdissociatefrom any violation ofsuchlaws, rules, or

regulations

I

Professor’sNote:Whilewe usetheterm “members”inthefollowing,notethat all

ofthe Standardsapply tocandidatesaswell

Guidance—Code and Standardsvs.LocalLawMembersmustknow the laws and regulations relatingtotheir professionalactivities inall countries inwhich they conduct business.Membersmustcomply withapplicablelaws and regulations relatingtotheir professionalactivity Donotviolate Codeor

Standardsevenifthe activityisotherwise legal Always adheretothemoststrictrulesand requirements(laworCFA Institute Standards)that apply

Guidance—ParticipationorAssociation With ViolationsbyOthersMembersshoulddissociate, or separate themselves,from any ongoing clientoremployeeactivitythatisillegalorunethical,evenifitinvolves leavinganemployer(an extreme

case).Whileamember may confront theinvolved individualfirst,hemustapproachhis supervisororcompliance department.Inactionwith continuedassociation maybeconstruedasknowingparticipation

Recommended ProceduresforCompliance—Members

• Membersshouldhaveprocedurestokeepupwith changesinapplicablelaws, rules,and regulations

• Compliance procedures shouldbe reviewedon anongoing basisto assurethattheyaddresscurrentlaw, CFAI Standards,and regulations

• Membersshouldmaintain currentreference materials foremployeesto accessinordertokeepuptodateonlaws, rules,and regulations

• Members should seek adviceof counselortheir compliance department whenindoubt

• Membersshould documentanyviolationswhenthey disassociate themselvesfromprohibitedactivityandencouragetheir employerstobringanendtosuchactivity

• Thereisnorequirement under the Standardsto reportviolationstogovernmentalauthorities,but thismaybe advisableinsomecircumstancesand required by lawinothers

• Membersarestrongly encouragedto reportother members’ violationsoftheCodeand Standards

Recommended ProceduresforCompliance—Firms

Members shouldencouragetheir firmsto:

• Develop and/or adoptacodeof ethics

• Make availabletoemployees information that highlightsapplicable laws and

regulations

• Establishwrittenprocedures for reporting suspected violation oflaws,regulations,or

companypolicies

Members who supervise thecreationandmaintenanceofinvestment servicesand

products should beawareof and comply with the regulations and laws regarding such

servicesand products bothintheircountryof origin and thecountrieswherethey will

be sold

ApplicationofStandard1(A)KnowledgeoftheLauP

Example1:

Michael Allen worksforabrokerage firm andisresponsible foranunderwriting of

securities Acompany official gives Allen information indicating that the financial

statementsAllen filed with the regulatoroverstatethe issuer’s earnings Allen seeks the

adviceof the brokerage firm’s generalcounsel,whostatesthatitwould be difficultfor

the regulatortoprovethat Allen has been involvedin anywrongdoing

Comment:

Althoughit isrecommendedthat members and candidates seek the advice of legal

counsel,the relianceonsuch advice doesnotabsolveamemberorcandidate from the

requirementtocomply with the laworregulation Allen shouldreportthissituationto

his supervisor, seekanindependent legal opinion, and determine whether the regulator

should be notifiedof theerror

Example2:

Kamisha Washington’s firm advertisesitspastperformance record by showing the

10-yearreturnofacompositeofitsclientaccounts.However,Washington discovers that the

compositeomitstheperformance ofaccountsthat have left the firm during the10-year

period and that thisomissionhas ledtoaninflatedperformance figure Washington

isaskedto usepromotional material that includes theerroneousperformance number

when soliciting business for the firm

Comment:

Misrepresentingperformanceisaviolationof the Code and Standards Although she did

notcalculate theperformanceherself,Washington would be assistinginviolating this

standard if shewere tousethe inflatedperformance number when soliciting clients She

mustdissociate herselffrom theactivity.Shecanbring the misleading numbertothe

attentionof thepersonresponsible for calculating performance, her supervisor,orthe

compliance departmentather firm If her firmisunwillingtorecalculateperformance,

shemustrefrainfrom using the misleading promotional material and should notify

the firmof herreasons.If the firminsiststhat sheusethematerial,she should consider

whether her obligationtodissociate from theactivitywould require hertoseek other

employment

3 Ibid

Example 4:

LauraJameson,aU.S.citizen,worksforaninvestmentadvisor basedinthe UnitedStatesand worksina countrywhere investment managersareprohibitedfromparticipatinginIPOsfortheirown accounts.

Comment:

Jamesonmustcomplywith thestrictestrequirements among U.S.law(whereherfirm

is based),theCFA InstituteCode andStandards,and the lawsof thecountrywhere she

isdoing business.In thiscasethat means shemust notparticipate in any IPOs for herpersonalaccount.

Example 5:

A juniorportfoliomanagersuspectsthatabrokerresponsiblefor newbusinessfrom

aforeigncountryisbeing allocatedaportion of the firm’spaymentsfor third-partyresearchandsuspectsthatnoresearchisbeing provided.Hebelieves that the researchpaymentsmaybe inappropriate and unethical

Comment:

Heshouldfollow his firm’sproceduresfor reportingpossible unethicalbehaviorandtry

to getbetter disclosureof thenatureof thesepaymentsandanyresearch thatisbeingprovided

1(B) IndependenceandObjectivity.Members andCandidatesmust usereasonable

careand judgmenttoachieveandmaintainindependence and objectivityin theirprofessionalactivities.Membersand Candidatesmust not offer,solicit,or acceptanygift,benefit, compensation,orconsideration thatreasonably could be expectedto

compromisetheirown oranother’s independenceandobjectivity

Guidance

Donotlet the investment process beinfluenced byanyexternalsources.Modest gifts

arepermitted Allocation of sharesinoversubscribedIPOstopersonalaccountsisNOTpermitted Distinguish between giftsfrom clientsand giftsfrom entitiesseekinginfluenceto the detrimentof theclient.Giftsmustbe disclosedtothe member’semployerinanycase,either priorto acceptanceif possible,orsubsequently

Donotbe pressured by sell-side firmstoissuefavorable researchon currentor

prospective investment-banking clients Itisappropriatetohaveanalysts work with

investmentbankersin“road shows” only when the conflictsareadequately and

effectively managed and disclosed.Be surethereareeffective “firewalls” between

research/investmentmanagementandinvestmentbankingactivities

Guidance—Public Companies

Analysts shouldnotbe pressuredtoissuefavorable researchby the companies they

follow.Donotconfine researchtodiscussions withcompanymanagement,but rather

use avarietyofsources,including suppliers,customers,and competitors

Guidance—Buy-Side Clients

Buy-side clientsmaytry topressuresell-side analysts Portfoliomanagers mayhave large

positionsinaparticularsecurity,andaratingdowngrademayhaveaneffectonthe

portfolio performance.Asaportfoliomanager,thereisaresponsibilityto respectand

foster intellectual honesty of sell-side research

Guidance—Fund Manager and Custodial Relationships

Members responsible for selecting outsidemanagersshouldnot acceptgifts,

entertainment,ortravel that might be perceivedasimpairing theirobjectivity

Guidance— PerformanceMeasurementand Attribution

Performance analystsmayexperiencepressurefrominvestment managerswho have

producedpoorresultsoractedoutside their mandate Members and candidates who

analyzeperformancemust notlet such influences affect their analysis

Guidance—Manager Selection

Members and candidatesmustexerciseindependence andobjectivitywhenthey select

investmentmanagers They shouldnot acceptgiftsorother compensation that could

beseenasinfluencingtheirhiringdecisions,norshould they offer compensation

when seekingtobe hiredasinvestmentmanagers Theresponsibilitytomaintain

independence andobjectivityappliestoallamemberorcandidate’shiringandfiring

decisions,notjust those that involveinvestmentmanagement.

Guidance—Credit RatingAgencies

Members employed by credit rating firms should makesurethat proceduresprevent

undue influence by the firm issuing thesecurities.Members whousecredit ratings

should beawareof this potential conflict ofinterestand consider whether independent

analysisiswarranted

Guidance—Issuer-Paid ResearchRemember that thistypeof researchisfraught withpotential conflicts Analysts’

compensation for preparing such research should belimited,and thepreferenceisfora

flatfee,without regardtoconclusionsorthe report’s recommendations

Guidance—TravelBestpracticeisfor analyststopayfor theirowncommercial travel when attendinginformationevents or tourssponsored by the firm being analyzed

Recommended ProceduresforCompliance

• Protectthe integrity of opinions—makesuretheyareunbiased

• Createarestricted list and distribute only factual information aboutcompanies onthe list

• Restrictspecialcost arrangements—payfor one’sowncommercial transportationandhotel;limituseofcorporateaircraftto casesinwhich commercial transportation

isnotavailable

• Limitgifts—tokenitemsonly Customary, business-relatedentertainment isokay

aslongasits purpose isnot toinfluenceamember’s professional independenceor

objectivity.Firmsshould impose clear value limitsongifts

• Restrictemployeeinvestments inequity IPOs and privateplacements Require pre¬

approval of IPO purchases

• Reviewprocedures—have effective supervisory andreviewprocedures

• Firmsshould have formalwrittenpoliciesonindependence and objectivity ofresearch

• Firmsshould appointacompliance officer and provide clear procedures foremployee reporting of unethical behavior and violations of applicable regulations

ApplicationofStandard1(B)Independence and ObjectivityExample1:

StevenTaylor,amining analyst with BronsonBrokers, isinvited byPrecisionMetalstojoinagroupof hispeers ina tourof mining facilitiesinseveralwesternU.S.states.Thecompanyarranges for chartered groupflights fromsitetositeandfor accommodations

inSpartanMotels,the only chain with accommodationsnearthemines,for three nights

Taylor allowsPrecisionMetalstopick up histab,asdo the other analysts, withoneexception— JohnAdams,anemployee ofalargetrustcompanywhoinsistsonfollowinghiscompany’spolicy and paying for his hotelroomhimself

onamemberorcandidate’s independence and objectivity.Inthis example, the tripwas

strictly for business and Taylorwas notaccepting irrelevantorlavish hospitality Theitineraryrequired chartered flights, for which analystswerenotexpectedtopay Theaccommodationsweremodest Thesearrangements are notunusual and didnotviolateStandard1(B)solongasTaylor’s independence and objectivitywerenotcompromised

In the finalanalysis, members and candidates should consider both whether theycan

remainobjective and whether their integritymight be perceived by their clientstohave

been compromised

Example2:

WalterFritz is anequity analyst with HiltonBrokerage whocoversthe mining industry

Hehas concluded that the stock of Metals&Miningisoverpricedatitscurrentlevel,

but heisconcerned thatanegative researchreportwill hurt thegoodrelationship

between Metals&Mining and theinvestment-banking division of his firm Infact,a

seniormanager of HiltonBrokerage has justsenthimacopyofaproposal his firm has

madetoMetals&Miningtounderwriteadebt offering.Fritzneedstoproducea report

rightawayandisconcerned about issuingaless-than-favorable rating

Comment:

Fritz’s analysis of Metals&Miningmustbe objective and based solelyonconsideration

ofcompanyfundamentals Anypressurefrom other divisions of his firmis inappropriate

This conflict could have been eliminatedif, inanticipation of the offering, Hilton

Brokerage had placed Metals&Miningonarestricted listforitssalesforce

Example3:

Tom Wayneistheinvestmentmanager of the Franklin CityEmployeesPensionPlan

Herecently completedasuccessful searchforfirmstomanage theforeignequity

allocationof the plan’s diversified portfolio.Hefollowed the plan’s standard procedure

of seeking presentations fromanumberof qualified firms and recommended that his

board select Penguin Advisors because ofitsexperience, well-definedinvestmentstrategy,

andperformancerecord,whichwascompiled and verifiedinaccordance with the

CFAInstituteGlobalInvestmentPerformance Standards Following the plan selection

of Penguin,a reporterfrom the Franklin City Record calledtoask if therewasany

connectionbetween theactionand thefact that Penguinwasoneof the sponsors ofan

“investmentfact-findingtriptoAsia”that Wayne made earlierintheyear.The tripwas

oneof several conducted by thePensionInvestmentAcademy, which had arranged the

itinerary of meetings witheconomic, government,andcorporateofficialsinmajorcities

inseveralAsian countries.ThePensionInvestmentAcademy obtainssupportfor thecost

of these trips fromanumberofinvestmentmanagers,includingPenguinAdvisors;the

Academy then pays the travelexpensesof thevariouspensionplanmanagersonthe trip

andprovides all meals and accommodations The president of Penguin Advisorswasone

of the travelersonthe trip

Comment:

AlthoughWaynecanprobablyput togoodusetheknowledgehegainedfrom the trip

inselecting portfolio managers andinotherareasof managing the pension plan, his

recommendationof Penguin Advisorsmaybe tainted by the possible conflict incurred

when he participatedinatrippaid for partly by Penguin Advisors and when hewasin

thedailycompanyof the president of Penguin Advisors.ToavoidviolatingStandard

1(B),Wayne’s basicexpensesfor travel and accommodations should have been paid

by his employerorthe pension plan;contactwith the president of Penguin Advisors

should have been limitedtoinformationaloreducationaleventsonly; and the trip, the

organizer, and thesponsorshould havebeen madea matterof public record Even if his

actionswerenotinviolationof Standard1(B),Wayne should have beensensitivetothe

public perception of the trip when reportedinthenewspaperand theextent towhich

the subjective elements of his decision might have been affected by the familiarity that

the dailycontactof suchatrip wouldencourage.This advantage would probablynotbesharedby competing firms.

Research opinions and recommendationsmustbe objective and arrivedatindependently

Following the boss’sinstructionswould beaviolation if theanalyst determinedabuyratingisinappropriate

Example7:

Ananalystentersintoa contract towritearesearchreportonacompany,paid for

by thatcompany,foraflat fee plusabonus basedonattractingnewinvestorstothesecurity

Comment:

Thisisaviolation because the compensationstructuremakes total compensation depend

onthe conclusionsof thereport (afavorablereportwillattractinvestorsandincreasecompensation) Accepting the job foraflat fee that doesnotdependonthereport’sconclusionsoritsimpactonshare priceispermitted, with proper disclosure of the factthat thereportisfunded by the subjectcompany

Example 9:

Ananalyst performing sensitivity analysis forasecurity doesnotuseonlyscenarios

consistentwithrecenttrends and historicalnorms

Comment:

Thisisagood thing andisnot aviolation

Example10

Amemberwhose firmisseekingtobecomean investmentmanager foralaborunion

contributesalargesum totheunionleader’s re-election campaign After theunion

hires the member’sfirm,the membercontinuestospendsignificantamountson

entertainmentfor theunionleader and his family

Comment:

Offering giftsorother compensationtoinfluenceadecisiontohirean investment

manager isaviolationof Standard1(B)

Example11

Amember whoisaperformance analystnoticesthatoneof her firm’stopinvestment

managershas changed his compositeconstruction,removingapoorly performing large

accountandplacingit inadifferent composite Knowing that theinvestmentmanager

isimportanttothe firm andaclose friendof the firm’sCEO,the member doesnot

disclose thischangeinherperformancereport.

Comment:

The member violated Standard1(B)by failingtoexerciseindependence and objectivity

inher analysis.Alteringcompositestoconcealpoorperformance also violates Standard

III(D)PerformancePresentationandmayviolate Standard1(C)Misrepresentation

1(C) Misrepresentation.Members and Candidatesmust notknowingly makeany

misrepresentations relatingtoinvestmentanalysis,recommendations,actions, orother

professionalactivities

Guidance

Trustisafoundationintheinvestmentprofession.Donotmakeanymisrepresentations

orgive false impressions This includesoral, electronic,and social media

communications.Misrepresentations include guaranteeinginvestmentperformance

and plagiarism Plagiarismencompassesusingsomeoneelse’s work (reports,forecasts,

models, ideas, charts,graphs, and spreadsheetmodels)without giving them credit

Knowingly omitting information that could affectan investmentdecisionor

performance evaluationisconsidered misrepresentation

Models and analysis developed by othersat amember’s firmarethepropertyof the firm

andcanbe used without attribution.Areportwrittenby another analyst employed by

the firmcannotbereleasedasanotheranalyst’s work

Recommended ProceduresforCompliance

Agoodwaytoavoid misrepresentationisfor firmstoprovide employees who deal withclientsorprospects awrittenlistof the firm’s availableservicesandadescription of thefirm’s qualifications Employee qualifications should be accurately presentedaswell

To avoid plagiarism,maintainrecordsof all materials usedto generate reportsorotherfirm products and properlycite sources(quotes andsummaries)inwork products

Informationfrom recognized financial and statistical reportingservicesneednotbecited

Members shouldencouragetheir firmstoestablish procedures for verifying marketingclaimsof thirdpartieswhose information the firm providestoclients

ApplicationofStandardI(C)MisrepresentationExample1:

AnthonyMcGuire is anissuer-paid analyst hired by publicly traded companiestoelectronicallypromotetheir stocks.McGuirecreates awebsite thatpromoteshisresearch effortsas aseeminglyindependent analyst.McGuireposts aprofile anda strong

buy recommendation for each companyonthewebsite,indicating that the stockisexpectedtoincrease invalue He doesnotdisclose the contractual relationships with thecompanies hecovers onhiswebsite, inthe researchreportsheissues, orinthestatements

he makes about thecompanies in Internetchatrooms

Comment:

McGuirehas violated Standard1(C)because theInternet siteand e-mailsaremisleading

topotentialinvestors.Even if the recommendationsarevalid and supported withthoroughresearch,hisomissionsregarding thetruerelationship between himself and thecompanieshecoversconstituteamisrepresentation.McGuirehas also violated StandardVI(A)Disclosureof Conflicts bynotdisclosing theexistenceofan arrangementwith thecompaniesthrough which hereceivescompensationinexchange for hisservices

Example2:

Claude Browning,aquantitative analyst for DoubleAlpha,Inc., returnsingreatexcitementfromaseminar.Inthatseminar,JackJorrely,awell-publicized quantitativeanalystat anational brokeragefirm,discussedoneof hisnewmodelsingreatdetail,and Browningisintriguedby thenewconcepts.Heproceedsto testthismodel,making

someminormechanical changes but retaining theconcept,until he producessomeverypositive results Browning quicklyannouncestohis supervisorsatDouble Alphathat he has discovereda newmodel and that clients and prospective clients alike should

be informedof this positivefindingasongoing proof of Double Alphas continuinginnovationand abilitytoadd value

Comment:

AlthoughBrowning tested Jorrely’s modelonhisownandevenslightlymodifiedit,he

muststill acknowledge the originalsourceof the idea Browningcancertainly take creditfor thefinal,practicalresults;hecanalsosupporthis conclusions with hisowntest.Thecreditfor theinnovativethinking,however,mustbe awardedtoJorrely

Example 3:

Paul Ostrowskirunsa2-person investmentmanagementfirm Ostrowski’s firm

subscribesto aservicefromalargeinvestmentresearch firm that provides research

reportsthatcanbe repackaged by smaller firms for those firms’ clients Ostrowski’s firm

distributes thesereports toclientsasitsownwork

Comment:

Ostrowskicanrelyonthird-party research that hasareasonable and adequatebasis,

but hecannotimply that heisthe authorof thereport.Otherwise,Ostrowski would

misrepresent theextentof his workinawaythat would mislead the firm’s clientsor

prospective clients

Example 4:

Amember makesan errorinpreparingmarketing materials andmisstatestheamountof

assetshis firm has undermanagement.

Comment:

The membermust attempt to stopdistributionof theerroneousmaterialassoonas

theerror isknown Simply making theerrorunintentionallyisnot aviolation,but

continuingtodistribute material knowntocontainasignificantmisstatementof fact

would be

Example 5:

Themarketingdepartmentstatesinsales literature thatananalyst has receivedan MBA

degree, but he hasnot.Theanalyst and other members of the firm have distributed this

documentforyears

Comment:

Theanalyst has violated theStandards,ashe should have knownof this

misrepresentation after having distributed and used the materialsover aperiod ofyears

Example6:

Amember describesaninterest-only collateralizedmortgageobligationasguaranteed by

the U.S.governmentbecauseit isaclaim against the cash flows ofapool of guaranteed

mortgages,although thepayment streamand the market valueof thesecurity arenot

Thisisnot aviolationaslongasthe limitsof theguaranteeprovided by the Federal

Deposit InsuranceCorporationare notexceeded and thenatureof theguaranteeis

clearly explainedtoclients

Totheextentthatthe candidate used information and interpretation from the financialpublication without citingit,the candidateis inviolationof the Standard Thecandidateshould either obtain thereportandreferenceitdirectlyor,ifhe relies solely

onthe financial publication, shouldcitebothsources.

1(D) Misconduct Members and Candidatesmust notengagein anyprofessionalconduct involving dishonesty,fraud,ordeceitorcommit anyactthat reflectsadverselyontheir professional reputation, integrity,or competence.

GuidanceCFAInstitutediscourages unethical behaviorinallaspectsof members’ and candidates’

lives.Donotabuse CFA Institute’s Professional Conduct Program by seekingenforcement of this Standardtosettle personal, political,orother disputes thatare not

relatedtoprofessional ethics

Recommended ProceduresforComplianceFirmsareencouragedtoadopt these policies and procedures:

• Develop and adoptacodeof ethics and make clear that unethical behavior willnot

be tolerated

• Giveemployeesalistof potential violations andsanctions,including dismissal

• Checkreferences of potential employees

ApplicationofStandard1(D)MisconductExample1:

SimonSassermanisa trustinvestmentofficerat abankinasmall affluenttown.Heenjoyslunchingeveryday with friendsatthecountryclub,where his clients haveobserved him havingnumerousdrinks Backatworkafterlunch,he clearlyisintoxicatedwhile makinginvestmentdecisions.Hiscolleagues makeapoint of handlinganybusiness withSasserman inthe morning because they distrust his judgment after lunch

Sasserman’sexcessivedrinkingatlunch and subsequentintoxicationatworkconstitute

aviolationof Standard1(D)because this conduct has raised questions about his

professionalism andcompetence.Hisbehavior thus reflects poorlyonhim,his employer,

and theinvestmentindustry

Example2:

Carmen Garcia managesamutual fund dedicatedtosocially responsible investing Sheis

alsoanenvironmentalactivist.Asthe resultof her participationatnonviolentprotests,

Garciahas been arrestedonnumerous occasionsfor trespassingonthepropertyofa

large petrochemical plant thatisaccusedof damaging theenvironment

Comment:

Generally, Standard1(D) isnot meant to coverlegal transgressions resulting fromacts

of civildisobedienceinsupportof personal beliefs because such conduct doesnotreflect

poorlyonthe memberorcandidate’s professional reputation, integrity,or competence.

Amember tellsaclient that hecangetheragood dealona carthrough his

father-in-law,but insteadgetsherapoordeal andaccepts partof thecommissiononthecar

purchase

Comment:

The member has been dishonest and misrepresented the facts of thesituationandhas,

therefore,violated the Standard

II Integrity ofCapitalMarkets

11(A) Material Nonpublic Information Members and Candidates who possess

material nonpublic information that could affect the value ofaninvestmentmust not

actorcauseothersto acton theinformation

Guidance

Informationis“material” ifitsdisclosure would impact the price ofasecurity orif

reasonableinvestorswouldwantthe information beforemakingan investmentdecision

Ambiguousinformation,asfarasitslikely effectonprice,maynotbe considered

material Informationis“nonpublic” untilithas been made availabletothe marketplace

Ananalyst conference callisnotpublic disclosure Selectively disclosing information by

corporationscreatesthe potential for insider-trading violations The prohibition against

actingonmaterial nonpublic information extendstomutual funds containing thesubjectsecuritiesaswellasrelatedswapsand optionscontracts.

Some membersand candidatesmaybe involvedin transactionsduringwhich theyreceivematerial nonpublic information provided by firms (e.g.,investmentbanking

transactions).Members and candidatesmayusethe provided nonpublic information foritsintended purpose, butmust not usethe informationforanyother purpose unlessitbecomes public information

Guidance—MosaicTheoryThereisnoviolation whenaperceptive analyst reachesan investmentconclusion about

a corporateactionor eventthroughananalysis of public information together withitemsof nonmaterial nonpublic information

Guidance—Social MediaWhen gathering information frominternetorsocial mediasources,members andcandidates needtobeawarethatnotall ofit isconsidered public information Membersand candidates should confirm thatanymaterial information theyreceivefrom thesesources isalso availablefrom publicsources,suchascompany press releasesorregulatoryfilings

Guidance—Industry ExpertsMembers and candidatesmayseek insight from individuals who have specializedexpertiseinanindustry.However,theymaynot act or causeothersto act onanymaterial nonpublic information obtained from theseexpertsuntil that information hasbeen publicly disseminated

Recommended ProceduresforComplianceMake reasonableeffortstoachieve public dissemination of the information.Encouragefirmstoadopt proceduresto preventmisuseof material nonpublic information.Usea

“firewall” within thefirm,with elements including:

• Substantial control of relevant interdepartmentalcommunications,througha

clearanceareasuchasthe complianceorlegaldepartment

• Reviewemployee trades—maintain “watch,” “restricted,”and“rumor” lists

• Monitorandrestrictproprietarytrading whileafirmis inpossession of materialnonpublic information

Prohibitionof all proprietary trading whileafirmis inpossession of materialnonpublicinformationmaybe inappropriate becauseit maysendasignaltothe market In these

cases,firms should take thecontraside of only unsolicitedcustomertrades

ApplicationofStandard11(A)Material NonpublicInformation

Example1:

SamuelPeter,ananalyst with Scotland andPierce,Inc., isassisting his firm witha

secondary offering for Bright Ideas Lamp Company.Peterparticipates,viatelephone

conferencecall, inameeting with Scotland andPierceinvestment-banking employees

and Bright Ideas’ CEO Peterisadvised that thecompany’searnings projections for

thenextyearhave significantly dropped Throughout the telephone conferencecall,

several Scotland andPiercesalespeople and portfolio managers walkinandoutof

Peter’soffice,where the telephone callistakingplace Asaresult,theyare awareof the

dropinprojected earnings forBright Ideas Before the conference callis concluded,

the salespeople trade the stock of the companyonbehalfof the firm’sclients,and other

firm personnel trade the stockinafirm proprietaryaccountandinemployee personal

accounts.

Comment:

Peterviolated Standard11(A)because he failedto preventthetransfer andmisuseof

material nonpublic informationtoothersinhis firm.Peter’s firm should have adopted

information barriersto preventthecommunicationof nonpublic information between

departments of the firm The salespeople and portfoliomanagerswho tradedonthe

information have also violated Standard11(A)by tradingoninside information

Example2:

ElizabethLevenson isbasedinTaipei andcoverstheTaiwanesemarketfor her

firm,whichisbasedinSingapore Sheisinvitedto meetthe finance directorofa

manufacturing company, along with the othertenlargest shareholders of the company

During the meeting, the finance directorstatesthatthecompanyexpectsitsworkforce

tostrikenextFriday, which will cripple productivity and distribution CanLevensonuse

this informationas abasistochangeher ratingonthecompanyfrom “buy”to“sell”?

Comment:

Levensonmustfirst determine whether the material informationispublic If the

companyhasnotmade this information public(asmall-groupforum doesnotqualify

as amethodof publicdissemination),shecannot usethe information accordingto

Standard11(A).

Example3:

Jagdish Tejaisabuy-side analyst covering the furniture industry Looking foran

attractive companytorecommendas abuy, he analyzed several furniture makers by

studying their financialreportsand visiting their operations.Healso talkedtosome

designersand retailerstofindoutwhich furniture stylesaretrendy and popular

Althoughnoneof the companies that he analyzed turnedout tobeaclear buy, he

discovered thatoneofthem,SwanFurnitureCompany(SFC),mightbeintrouble

Swan’sextravagant newdesignswereintroducedatsubstantialcosts.Eventhough

thesedesignsinitially attractedattention,inthelongrun,the publicisbuyingmore

conservativefurniturefrom other makers Basedonthat andonP&Lanalysis, Teja

believes that Swan’snext-quarterearnings will drop substantially He thenissuesasell

recommendationfor SFC Immediately after receiving thatrecommendation, investment

managersstartreducingthe stockintheir portfolios

Comment:

Informationonquarterly earnings figuresismaterial and nonpublic.However,Teja

arrivedathis conclusion about the earnings drop basedonpublic information and

onpieces of nonmaterialnonpublic information(suchasopinions of designers and

retailers) Therefore,tradingbased onTeja’scorrectconclusionisnotprohibited by

Standard11(A)

Example 4:

Amember’sdentist,whoisanactiveinvestor,tells the member that basedonhisresearch he believes thatAcme,Inc.,will be boughtoutinthenearfuture byalargerfirminthe industry The member investigates and purchases shares ofAcme

Amember receivedanadvance copy ofastock recommendationthat willappear ina

widely read nationalnewspapercolumn thenextday and purchases the stock

Comment:

Arecommendationinawidely readnewspapercolumn will likelycausethe stockpriceto rise, sothisismaterial nonpublic information The member has violated theStandard

Example 6:

A member trades basedoninformation hegetsby seeinganadvance copy ofanarticlethat will be publishedin aninfluential magazinenextweek

Comment:

Thisisaviolationasthisisnonpublic information until the article has been published

11(B) MarketManipulation Members and Candidatesmust notengageinpracticesthat distort pricesorartificially inflate trading volume with theintenttomisleadmarket participants

GuidanceThis Standard appliestotransactionsthat deceive the market by distorting the price¬

setting mechanism of financialinstrumentsorby securingacontrolling positionto

manipulate the price ofarelated derivative and/or theassetitself Spreading falserumors

isabouttoissuearesearchreport onWirewolfSemiconductor,which will include hisopinion that:

• Quarterlyrevenues arelikelytofall short ofmanagement’sguidance

• Earnings will beasmuchas5centspershare(ormorethan10%)belowconsensus.

• Wirewolf’s highly respected chief financial officermaybe abouttojoin another

company

Knowing that Wirewolf had already entereditsdeclared quarter-end “quiet period”

before reporting earnings(andthus would be reluctanttorespondto rumors, etc.),

Murphytimesthe releaseof his researchreportspecificallytosensationalize the negative

aspectsof the messageto createsignificant downward pressureonWirewolf’s stockto

the distinct advantage of Divisadero’s hedge fund clients The report’s conclusionsare

basedonspeculation,not onfact Thenextday, the researchreportisbroadcasttoall of

Divisadero’s clients andtothe usualnewswireservices

Before Wirewolf’sinvestorrelations departmentcanassessitsdamageonthefinal

trading day of thequarterandrefute Murphy’sreport,itsstock opens trading sharply

lower,allowing Divisadero’s clientstocovertheir short positionsatsubstantial gains

Comment:

Murphy violated Standard11(B)by tryingto createartificialpricevolatility designedto

have material impactonthe price ofanissuer’s stock.Moreover,by lackinganadequate

basisfor therecommendation,Murphy also violated StandardV(A)

Example2:

ACMEFuturesExchangeislaunchinga newbondfuturescontract.Toconvince

investors,traders,arbitragers,hedgers,andso on, to useitscontract,theexchange

attempts todemonstrate thatithas the best liquidity To doso,itentersintoagreements

with memberssothat theycommitto asubstantialminimumtradingvolumeonthe

newcontractoveraspecific periodinexchange for substantial reductionsontheir

regularcommissions

Comment:

The formal liquidity ofamarketisdetermined by the obligationssetonmarketmakers,

but the actual liquidity ofamarketisbetter estimated by the actual trading volume

and bid-ask spreads Attemptstomislead participantsonthe actual liquidity of the

marketconstituteaviolation of Standard11(B).Inthis example,investorshave been

intentionally misledtobelieve they chose themostliquidinstrumentforsomespecific

purposeand could eventuallyseethe actual liquidity of thecontractdryupsuddenly

after thetermof theagreementif the “pump-priming”strategyfails If ACMEfully

disclosesitsagreementwith memberstoboosttransactions over someinitial launch

period,itdoesnotviolate Standard11(B).ACME’sintent isnot toharminvestorsbuton

thecontrary togive themabetterservice.Forthatpurpose, it mayengageinaliquidity¬

pumpingstrategy,butitmustbe disclosed

Example 3:

Amemberisseekingtosellalargepositioninafairly illiquid stock fromafund he

manages.Hebuys and sells shares of the stock between that fund and another he also

managesto create anappearanceof activity and stock price appreciation,sothat the sale

of the whole position will have less market impact and he will realizeabetterreturnfor

thefund’s shareholders

The tradingactivity ismeant tomislead market participants andis,therefore,aviolation

ofthe Standard Thefact thathisfund shareholders gain bythis actiondoesnotchangethefact thatit isaviolation

III(A) Loyalty,Prudence,andCare.Membersand Candidateshaveadutyofloyalty

totheir clients andmust actwith reasonablecareandexerciseprudent judgment

Members and Candidatesmust actfor the benefit of their clients and place theirclients’interestsbefore theiremployer’sortheirown interests.

GuidanceClientinterestsalwayscomefirst.Although this Standard doesnotimposeafiduciarydutyonmembersorcandidates whereonedidnotalreadyexist, itdoes requiremembersand candidatesto actin theirclients’bestinterestand recommend products thataresuitable given their clients’investmentobjectivesand risk tolerances

• Exercisethe prudence,care,skill,and diligence under thecircumstancesthatapersonactinginalike capacity and familiar with suchmatterswoulduse.

• Managepoolsof clientassetsin accordance with thetermsof the governingdocuments,suchas trustdocumentsor investment management agreements.

• Makeinvestmentdecisionsinthecontextofthetotal portfolio

• Inform clients ofanylimitationsinanadvisory relationship (e.g.,anadvisor whomayonly recommendherownfirm’sproducts)

• Vote proxies inaninformed andresponsiblemanner.Dueto costbenefitconsiderations, it maynotbe necessaryto voteall proxies

• Client brokerage,or“soft dollars”or“softcommissions”mustbe usedtobenefit theclient

• The “client” may be the investingpublicas awholerather thanaspecificentityorperson

Recommended ProceduresofComplianceSubmittoclients,atleast quarterly, itemizedstatementsshowing allsecurities incustodyandalldebits, credits,andtransactions.

Encouragefirmstoaddress thesetopicswhen drafting policies and procedures regardingfiduciary duty:

• Follow applicable rules and laws

• Establishinvestmentobjectives of client Considersuitability ofportfolio relativeto

client’s needs andcircumstances,theinvestment’sbasiccharacteristics,orthe basic

characteristicsof the total portfolio

• Diversify

• Dealfairly with all clientsinregardstoinvestment actions

• Disclose conflicts

• Disclose compensationarrangements.

• Voteproxiesinthe bestinterestof clients and ultimate beneficiaries

• Maintainconfidentiality

• Seek bestexecution

• Place clientinterestsfirst

ApplicationofStandard111(A)Loyalty,Prudence,andCare

Example1:

FirstCountryBankserves as trusteefor the MillerCompany’spensionplan Miller

isthetargetofahostile takeoverattemptbyNewton,Inc Inattemptingtowardoff

Newton,Miller’smanagerspersuadeJulianWiley,aninvestment manageratFirst

CountryBank,topurchase Millercommonstockin the open market for the employee

pensionplan Miller’s officials indicate that suchactionwould befavorably received and

wouldprobably resultinotheraccountsbeing placed with the bank Although Wiley

believes the stocktobe overvalued and wouldnotordinarily buyit,he purchases the

stockto supportMiller’s managers,tomaintainthecompany’s goodfavor,andtorealize

additionalnewbusiness The heavy stock purchasescauseMiller’s market pricetoriseto

suchalevel thatNewtonretractsitstakeover bid

Comment:

Standard111(A)requires thatamemberorcandidate, inevaluatingatakeoverbid,act

prudently and solelyintheinterestsof planparticipantsandbeneficiaries.Tomeetthis

requirement,amemberorcandidatemustcarefully evaluate the long-termprospectsof

the company against the short-termprospectspresented by the takeover offer and by

the abilitytoinvestelsewhere In thisinstance,Wiley, actingonbehalfof his employer,

thetrustee,clearly violated Standard111(A)by using the pension planto perpetuate

existingmanagement,perhapstothe detriment of plan participants and thecompany’s

shareholders,andtobenefit himself Wiley’s responsibilitiestothe plan participants

and beneficiaries should take precedenceoverany tiesto corporatemanagersand

self-interest Adutyexiststoexaminesuchatakeoverofferon its own meritsandtomake

anindependent decision The guiding principleisthe appropriateness of theinvestment

decisiontothe pension plan,notwhether the decision benefits Wileyorthe company

that hired him

Example2:

EmilieRomeisa trustofficerfor PagetTrustCompany Rome’ssupervisor isresponsible

for reviewing Rome’strust accounttransactionsand her monthlyreportsof personal

stocktransactions.Romehas been using Nathan Gray,abroker,almost exclusively for

trust accountbrokeragetransactions.WhereGraymakesamarketin stocks,he has been

givingRomealower price for personal purchases andahigher price for sales than he

givestoRome’strust accountsand otherinvestors

of thisdecisionontheiraccounts.

Donotdiscriminate againstanyclients when disseminating recommendationsortaking

investment action.Fairly doesnot meanequally.In the normal courseofbusiness,therewillbe differencesinthetime e-mails, faxes,etc., arereceived by different clients

Different service levelsareokay,buttheymust notnegativelyaffectordisadvantageanyclients Disclose the differentservicelevelstoall clients andprospects,and makepremium levels ofserviceavailabletoall who wishtopay for them

Guidance—Investment Recommendations

Giveall clientsafair opportunityto actupon every recommendation Clients who

are unawareofachangeinarecommendation should be advised beforetheorderis

accepted

Guidance—InvestmentActions

Treat clients fairlyinlight oftheir investmentobjectives andcircumstances Treat

both individual and institutional clientsinafair and impartialmanner.Members and

candidates shouldnottakeadvantageof their position in theindustrytodisadvantage

clients(e.g.,in thecontextofIPOs).

Recommended ProceduresforCompliance

Encouragefirmstoestablish compliance proceduresrequiringproperdisseminationof

investmentrecommendations and fairtreatmentof allcustomersand clients Consider

thesepointswhen establishingfairdealing compliance procedures:

• Limit the number ofpeoplewhoare awarethatachangein recommendation will be

made

• Shortenthetimeframe betweendecision and dissemination

• Publish personnel guidelines for pre-dissemination—haveinplace guidelines

prohibiting personnelwho haveprior knowledge ofarecommendationfrom

discussingit ortakingaction onthepending recommendation

• Simultaneous disseminationofneworchanged recommendationstoall clients who

have expressedaninterestorfor whomaninvestment issuitable

• Maintainlistof clients and holdings—use to ensurethat all holdersaretreatedfairly

• Developwrittentradeallocationprocedures—ensure fairnessto clients,timelyand

efficient orderexecution,andaccuracy ofclientpositions

• Disclose trade allocation procedures

• Establishsystematicaccountreview—ensurethatnoclientisgivenpreferred

treatmentandthatinvestment actions are consistentwith theaccount’s objectives

• Disclose available levelsof service

ApplicationofStandardIII(B) FairDealing

Example1:

BradleyAmes, awell-known and respected analyst, follows thecomputerindustry In

thecourseofhisresearch,he findsthatasmall,relatively unknowncompanywhose

sharesaretradedoverthecounterhas justsigned significantcontractswithsomeof the

companieshe follows.Afteraconsiderableamountofinvestigation,Amesdecidesto

write aresearchreport onthe company and recommendpurchase While thereportis

being reviewed by thecompanyfor factualaccuracy, Amesschedulesaluncheon with

severalof his best clientstodiscussthe company At theluncheon,hementionsthe

purchase recommendation scheduledtobesentearly the following weektoall the firm’s

clients

Amesviolated Standard III(B) by disseminating the purchase recommendationtotheclients with whomhehad lunchaweekbefore therecommendationwas sent toallclients

Example2:

SpencerRivers,presidentofXYZ Corporation,moveshiscompany’s growth-orientedpension fund to aparticularbankprimarily because of the excellentinvestmentperformance achieved bythebank’s commingled fundfortheprior5-yearperiod.Afewyearslater,Rivers comparesthe resultsof his pension fund with those of the bank’scommingled fund.Heisstartledtolearn that, eventhoughthetwo accountshave the

sameinvestmentobjectives and similarportfolios, his company’s pension fund hassignificantly underperformedthebank’s commingled fund Questioning this resultat

hisnextmeeting withthe pension fund’s manager, Rivers istoldthat, as a matterofpolicy,whena newsecurity isplacedontherecommendedlist,Morgan Jackson,thepension fundmanager,first purchases thesecurityfor the commingledaccountand thenpurchasesiton aproratabasisfor allotherpensionfundaccounts.Similarly, whenasale is recommended, the security is soldfirstfromthecommingledaccountand thensoldon aproratabasisfrom all otheraccounts.Riversalso learns that ifthe bankcannot

getenough shares(especially the hotissues) tobemeaningfultoall theaccounts, its

policyis toplace thenewissuesonlyin thecommingledaccount.

Seeingthat Riversisneither satisfiednorpleased by the explanation,Jacksonquicklyadds that nondiscretionary pensionaccountsand personaltrust accountshavealowerpriorityonpurchase and sale recommendations than discretionary pension fund

accounts Furthermore,Jacksonstates,thecompany’spensionfund hadthe opportunity

to investupto5%in thecommingled fund

Comment:

The bank’s policy didnot treatallcustomersfairly, andJacksonviolated her dutyto

her clientsbygiving prioritytothegrowth-oriented commingled fundover all otherfunds andtodiscretionaryaccounts overnondiscretionaryaccounts.Jacksonmust executeorderson asystematicbasisthatisfairtoallclients.In addition,tradeallocationprocedures should be disclosedtoall clients from the beginning Ofcourse,inthiscase,disclosureof the bank’spolicy wouldnotchangethefact that thepolicyisunfair